Bank of Lithuania
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2015-04-23

Leading indicators for the countercyclical capital buffer in Lithuania

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This paper presents the analysis of indicators that could signal the build-up of systemic risk in Lithuania during the periods of credit expansion. The resulting set of early warning indicators could be useful in operationalizing countercyclical macroprudential policy measures, especially the countercyclical capital buffer (CCB). It could serve as a starting point in considerations whether there is a need to increase banks’ resilience in the upturn of financial cycle by accumulating additional capital buffers.
Taking into account the short Lithuanian data series which cover only one systemic banking crisis period, the analysis is extensively based on international research, particularly on findings of the European Systemic Risk Board (ESRB) Expert Group which provided analysis for the ESRB Recommendation on guidance on setting countercyclical buffer rates (ESRB 2014/1). Consistent with the existing research, we show that the deviation of the ratio of credit to gross domestic product (GDP) from its long-term trend (credit-to-GDP gap) is a suitable early warning indicator of financial crises in Lithuania. However, gap estimation faces uncertainty as the long-term trend is unobservable. To deal with the uncertainty, the estimation of the long-term trend was augmented with forecasts and most suitable alternative to the so called standardised ‚Basel gap‘ (suggested by the BCBS) is provided. In addition to this, complementary early warning indicators have been selected that could give concise yet comprehensive and robust view of the state of the Lithuanian economy. The performance of selected early warning indicators has also been evaluated for the three Baltic states (Lithuania, Latvia and Estonia).

JEL Codes: C40, G01.

The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

countercyclical capital buffer (CCB), early warning indicators, credit-to-GDP gap, signalling approach